As the Chinese government’s “war on pollution” gains traction, it has come to reckon with the need to spend trillions of dollars to overcome its climate, water and land challenges. The People’s Bank of China estimates that annual investments in the order of 3 percent of the country’s GDP, or RMB 2 trillion ($330 billion), would be needed to overcome these problems from 2015 to 2020.

So where will this large amount of money come from?

A big part of the answer lies with the country’s private sector. The government envisages picking up only 10-15 percent of the total tab in responding to green investment needs. With some action from the public sector to de-risk and crowd-in private finance and policy nudges from government, China could attract more private investments and become a global leader in green finance.

Why Is Green Finance Lacking?

China’s current green investment shortage is not due to lack of funds: there are enormous sums of money available in the private sector. According to the State Administration of Foreign Exchange, funds managed by Chinese and foreign institutional investors in China exceeded RMB 1 trillion ($163 billion) earlier this year. China enjoys the world’s highest domestic savings rate. And the recent establishment of the Asian Infrastructure Investment Bank (AIIB), the BRICS Development Bank and the Silk Road Fund are indications of China’s eagerness to find new avenues for its surplus capital, as dwindling prospects at home drive investors abroad in search of higher returns.

The fundamental problem with attracting investment towards green sectors like renewable energy and energy efficiency is distorted price signals. The current system fails to take externalities into account. For example, products such as fuel cell electric vehicles make a positive contribution to the environment, but these benefits are not factored into their prices. Conversely, environmental damage from fossil fuel burning or a chemical plant is not accounted for either.

Moving Private Capital into Green Sectors

Green financial reform is thus part of a broader drive to rebalance an economy saddled by inefficiencies and misdirected investments. To advance this agenda, the China Council for International Cooperation on Environment and Development (CCICED) set up a Task Force to generate policy recommendations to the Chinese government on greening the country’s financial system. Co-chaired by Andrew Steer, president and CEO of WRI, and Chen Yulu, president of Renmin University of China, the Task Force is examining a wide range of areas from banking to securities to emissions trading systems for practical measures that could bring impacts quickly.

There are many policy recommendations to be considered on topics such as green credits, green securities, green funds, public-private partnerships and emissions trading. A recent meeting of the Task Force identified three as being important in the near-term:

1) Environmental information disclosure to increase transparency

Transparency is the basis for good regulation and wise investment decisions. When all stakeholders – including government, industry, impacted communities and civil society organizations – are consulted and have complete information on topics like investment flows, environmental/social impacts and mitigation measures, project developers and investors can make better decisions. The CCICED task force is identifying ways to promote transparency, including amendments to China’s commercial banking and securities laws to require that companies disclose information like environmental liability accidents and carbon footprints. This can help scale up green finance by making investors and the public more aware of the impacts of their invested money, so that they can avoid supporting companies and industries that could jeopardize their money’s future value.

2) Robust environmental and social standards for Chinese overseas investment

China’s global reach has expanded rapidly over the past decade. With the country spearheading new initiatives like the AIIB, the BRICS Development Bank and the Silk Road Fund, its overseas investment is poised to grow even faster. The international community is concerned with the environmental and social performance of Chinese investments in the future, both as an individual country and as a member of these new initiatives. And Chinese decision-makers are encouraged by the prospect of leapfrogging to a new frontier of best practices.

The Task Force recommends that these new institutions develop strong and enforceable environmental and social safeguards to prevent undue harm to the environment and communities. These standards will clarify the types of projects banks should fund, delineate expectations, as well as identify, mitigate and reduce risks arising from projects’ poor environmental and social performance. In addition, the Task Force calls for these new institutions to develop a green investment strategy and to leverage private capital.

3) Set up green investment banks in China

The Task Force is recommending that national and local green investment banks be established to increase financing to support the shift to a greener and more sustainable economy. A green bank is a financial institution specialized in providing financial support to low-carbon, climate-resilient projects. Its objective is to leverage public funds to attract private investments in low-carbon sectors like renewable energy development and sustainable transport. They are typically established with a legislative mandate or administrative order, but have a high degree of independence in running their daily operations and making investment decisions.

A number of countries have established green banks, including the United Kingdom, Australia and Japan. The UK Green Investment Bank, created in 2012, was set up with £3.8 billon ($59.4 billion) of UK government money, and has leveraged three times as much private capital in renewable energy and waste management . Some of the state green banks set up in the United States (such as Connecticut Green Bank) have achieved a leverage ratio of 10:1. There is a strong foundation of experience on which China can build, and the Task Force is engaging with these institutions to distill and adapt lessons learned to the Chinese context.

The Way Forward

The Chinese government attaches great importance to the role of finance in helping the country restructure its economy and rehabilitate an ancient civilization that was based on a balance between man and nature. As China examines its role in the global economy, expands its markets, and looks for ways to establish mutually beneficial relations with surrounding countries, it can both learn from international experience and also set a new standard of sustainable finance. The Task Force is helping China to achieve just that. It recommended that its policy suggestions be put on the agenda of the G20 Summit to be held in Beijing in 2016, so that both international and Chinese good practices can be simulated in other countries.